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Thursday, July 14, 2011

The House that Bogle Built

In The House that Bogle Built, author Lewis Braham tells the story of how John Bogle built Vanguard and championed low-cost index investing. This book is much more than just a historical account, though. Braham explains the different sides of various investing related arguments such as passive vs. active investing and more. Brahma isn’t shy about injecting his own opinions as well. However, where he differs with Bogle, I usually found Bogle’s arguments more convincing.

Braham is no breathless admirer of either Bogle or Vanguard. As one example, Braham calls one Vanguard advertising campaign a “schmaltzy video” containing “true sanctimony”.

A big part of Bogle’s achievement with Vanguard was to separate control over invested assets from the management of the assets. A competitor to Vanguard is quoted as saying “By giving the client a fair shake, you’re going to destroy this industry.” However, many of Vanguard’s competitors continue to “put the desire to earn profits for their management companies above the desire to earn profits for their shareholders.”

One area of Vanguard that Braham criticizes is its “Partnership Plan”. This plan pays a bonus to Vanguard employees based on a percentage of the money Vanguard saves its investors on management fees compared to the rest of the industry. Braham sees this plan driving Vanguard to sacrifice “potential outperformance in favor of asset gathering.” He thinks that Vanguard could do a better job trying to beat the market with its active funds instead of just getting bigger. I’d be more concerned about this if I thought they could beat the market consistently.

I find it interesting that Vanguard’s low-cost index ETFs are most useful to me, but Bogle is no fan of ETFs. ETFs are designed to be traded and Bogle has shown that investors tend to buy and sell them at the worst possible times. I’ll see what I can do to hold on for the long term.

Despite serious health problems most of his life, Bogle didn’t allow himself to be held back. His doctor reported that Bogle refused to quit playing squash and instead brought a defibrillator to the court. Bogle reported back to his doctor that “I’m consistently winning. My opponents are so demoralized and fearful they’ll have to resuscitate me, I beat them every time.”

In the latter part of the book, Braham justifies his beliefs in active investing, tactical asset allocation, and fundamental indexing. To his credit he explains the counterarguments as well. In general, I found the counterarguments more compelling.

On the subject of voting company shares, Braham calls on Vanguard to lead the industry in voting company shares against excessive compensation proposals for the company’s top management. This seems long overdue.

On the whole this book is a worthwhile read for its account of Bogle’s life, Vanguard’s history, and it’s tackling of contentious investing issues.

@Patrick: That does deserve some better explanation (which the book provides). There are two main functions of a mutual fund:

Steward: Look out for the interests of investors and their money.

Money Manager: Decide how to invest the money.

In Vanguard's case, they perform the Steward function as a non-profit and hire money managers (and replace them if necessary). Most other mutual funds have the same for-profit organization performing both functions. In these cases the organization seeks profits as a money manager and the Steward side suffers at investors' expense.